Islamic Banks Get a ‘Libor’ of Their Own | WSJ.COM

A group of 16 banks resolved a quandary that has dogged the $1 trillion Islamic financing market for nearly three decades: how to represent rates on interbank funding when Islamic principles prohibit firms from charging interest.

The banks—working with industry associations and data provider Thomson Reuters—created a reference rate called the Islamic Interbank Benchmark Rate, or IIBR, which was put into use for the first time Tuesday. The banks say the solution, which complies with Islamic moral codes, known as Shariah, lies in considering money flowing between banks as investments that depend on the performance of underlying assets, rather than as interest-bearing loans.

Scholars and bankers involved in the project say it is an industry milestone akin to the first globally issued Islamic corporate bond in 2001, or the first Islamic sovereign bond in 2002. They say the rate brings transparency to the Islamic financing process and could encourage broader use of Islamic banks.

“The establishment of the IIBR marks an important milestone in the maturation of Islamic money markets by providing an international reference rate for interbank transactions,” said Nasser Saidi, chairman of the Islamic Benchmark Committee and chief economist at the Dubai International Financial Centre, in a statement.

Islamic banks aren’t allowed to earn or pay interest, yet have been using an international interest-rate benchmark—the London interbank offered rate, or Libor—since 1986. While Libor isn’t compliant with Shariah, religious leaders permitted its use because there was no alternative benchmark based on socially ethical investing.

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Rather than measuring interest on loans as Libor does, IIBR uses expected profits from short-term money and a forecasted return on the assets of the bank receiving funds. Both are considered investments rather than loans, and therefore interest-free.

Associated Press

Chief economist of the Dubai International Financial Centre, building above, calls the Shariah rate a ‘milestone’

Sheikh Yusuf Talal Delorenzo, chairman of Thomson Reuters’s Shariah committee, said the significance of IIBR is that it allows firms participating “to see the interbank market in their own terms.”

“Earnings are lawful,” he said. “What is unlawful is earnings from interest.”

Hassan Demirhan, director in the treasury department at the Islamic Development Bank, added that the introduction of an “indigenous Islamic benchmark” will prove to be a “major milestone in the growth and sustainability of the industry.”

IIBR on everything from overnight to one-year funding will be determined from rates the member banks contribute each day. The data will go through a type of cleaning called a “fixing,” where the top and bottom rates are removed and an average of the middle eight contributions is taken.

The results are blessed by a panel of Islamic banks and approved by a committee of Shariah scholars. Also involved in the launch were the Islamic Development Bank, the Accounting and Auditing Organization for Islamic Financial Institutions, the Bahrain Association of Banks and the Association of Islamic Banking Institutions Malaysia.

As of Nov. 16, the theoretical overnight IIBR would have been 0.1%, which was slightly below overnight Libor of 0.14%. Libor was cheaper over one year, however, at 0.91% versus 1.01% for IIBR.

Such differences could encourage corporate borrowers to use Islamic banks when IIBR is lower than Libor, on the theory that banks could pass savings on to customers.

“It will facilitate liquidity into the Islamic banks,” said Rushdi Siddiqui, global head of Islamic finance at Thomson Reuters in New York, who helped launched the first Islamic equity index in 1999 for Dow Jones.

Islamic banks have attracted liquidity from outside investors interested in diversification, said Mr. Siddiqui, and this will provide those funding sources with “a transparent, visible benchmark” that will encourage increased funding flows, helping to finance a wave of infrastructure projects in the region.

The development of a Shariah-compliant benchmark rate also comes amid regulatory investigations into the way the Libor rate is fixed by investment banks. Regulators have opted not to specifically endorse IIBR over other benchmarks, preferring to remain neutral, but they are aware of its creation and have supported it.

16 responses to “Islamic Banks Get a ‘Libor’ of Their Own | WSJ.COM”

There is no such thing as an “Islamic Bond” – a bond by definition is an interest bearing financial instrument. Such “sukooks” are nothing but a deception perpetrated by so-called Islamic banks on gullible Muslims. These, and other corruption such as this IIBR (you can call it whatever it’s modelled after LIBOR) are bidahs or innovations that are not termed as such because all these scholars are also being paid by the banks.

Islamic banking is really easy and straightforward and you do not need all these fancy Arabic names to make it halal. You have a property you wish to buy, but cannot afford. You buy it and pay in installments. The seller can charge a high price for it because it’s not being paid all at once, but once the deal is done, it’s done. Unlike what most “Islamic” banks offer today. (Lease-to-own – what a scam!)

Price is fixed, amount you owe is fixed, and amount you pay per month does not depend on what is happening in the world (i.e. the LIBOR rate or the Bank of Canada interest rate etc.). Every month the amount you owe goes down as you pay.

This doesn’t happen with interest. Every month, if you just pay the interest owed on the loan, the total that is due back does not decrease by a single cent, regardless of how much you have paid till then.

You can get a fixed interest rate loan, where the interest rate does not adjust periodically based upon an index like LIBOR. You do not have to get an adjustable rate loan.

I see where the principal would not decrease if one were only making the interest payments, but most loans require the debtor to pay more than just the interest component every month.

Amortization is a useful tool for allocating regular equal monthly payments between an interest component and a principal component. You pay the same amount every month, but, each month, as the principal balance decreases, the amount going to interest decreases proportionally. Amortization does mean that principal is paid down slowly at first, but that is made up for toward the second half of the repayment period, as the principal balance starts to decrease every month at an accelerating rate.

If a seller cannot charge interest on unpaid principal, then he will probably just charge a higher price to compensate. In the end, the purchaser will probably end up paying more.

You can get a fixed interest rate loan, where the interest rate does not adjust periodically based upon an index like LIBOR. You do not have to get an adjustable rate loan.
If the total amount to be paid to the borrower is written in a contract agreement and this does not change anyway then it would be close to what is the Islamic loan ideal.

If a seller cannot charge interest on unpaid principal, then he will probably just charge a higher price to compensate.

That is correct. And that is usually how it’s supposed to operate under Islamic business principles. But once the price is agreed upon, it’s fixed. And this is where most Islamic banks fail – they try to charge interest by calling it something else, and have it variable, and so on and so forth.

On the surface, it may, but there are distinct differences. The amount paid in the installments is the principle, meaning, even if I increase my payment, the payoff amount remains fixed. The final amount paid to the owner of the product is agreed upon in advance and not a function of interest accrued on remaining principle.

a ver importnat part of this deal is the transfer of ownership of the item or goods which are the being traded. this coiuld be true in cases where the items are small and the payment tenure is say one year.(it is called mudharaba)

in cases of property since the amounts involved are huge and the re payment may take some years or a number of years a different method is applied. in this case all repayments cover a part of the profit/rental which is to be shared between the financer and the user/occupier and repurchases of the share of the other person (bank).

If it squeals like a pig, walks like a pig, talks like a pig, it’s still a pig. And it’s haram. This is why Muslims themselves don’t trust these so-called Islamic banks.

Islamic banks become a joke when they try to do what simple CAN NOT be done under Islamic law. Lend someone X amount of money and more than X amount back. They fall over themselves trying to call this ‘extra’ anything.

i think you have not studied the islamic banking and the various products being offered by these banks.
the real problem lies in our being not able to comprehend the difference. secondly since we are tuned to the conventional banking system we try to compare the shariah products with the products being offered by other banks and then come to the conclusions as stated by you.

the scholars have really put in lot of efforts in difining the rules for islamic banking business.
i swould request you to consider studinging what is shariah compliant business process and the see how these institutions are working.

I have an MBA and an accounting degree and I have studied most of these schemes, especially as they are being offered in Canada. I would advise you stop viewing anything endorsed by scholars as automatically legit and examine the issues with an open mind.

If all interest is haram, as the scholars themselves say, they can NEVER justify sukook or this so called Shariah compliant LIBOR rate.

As I said before, Islamic financing is very easy to understand. And how come no one invented these things 1400 years ago?

I’m sure there are some Islamic Banks that are just preying on gullible Muslims, but your blanket remark has far reaching implications. Namely, all Islamic Banks trying to provide and interest alternative are doing it wrong.

I’m specifically curious about the your remark regarding lease to own. Is it not that the bank and the customer by a property together (let’s say 60% 40%) then the bank leases it’s portion to the customer who pays a fixed rate to buy it over a period of time. Eventually, the customer owns 100% percent of the property.

Interest is treating money as a commodity as oppose to a medium of exchange. if the rates are based on investments…then I don’t see the issue. Please explain or if you have any articles about the topic throw them up inshalah.

The main problem with lease to own is that the risk and cost of ownership are not split evenly between the two owners (bank and homeowner). And not just that, there is a “reevaluation” every 5 years because ‘market has changed’ and somehow this reevaluation rate is equal to present interest mortgage rate at a conventional bank.